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All Things Tax

All Things Tax

Like the title says, from the filing process and tax questions to tax policy and reform, you can search and share All Things Tax here. This is the place to find answers to all your general questions that don't fall under the other categories. And just a reminder: questions about software or online filing should be posted in DIY Products.

Newly Self-Employed

I have been working for my father since March, and being paid 1099. My total for the year will be around $34,000 for 2017, and I haven't paid any taxes on this money yet. I work from home, and most of my work is done on the phone and computer. I need some advice. Should I file using the standard deduction or itemize it? Would I save any money by forming an LLC or S Corp? What about the "self-employment tax"? Is there anything that I should be doing to prepare for April? All of this is very new and confusing. I keep getting different answers. I'm in North Carolina, and trying to avoid overpaying. What is the minimum that I will pay regardless of accounting strategies?

Re: Newly Self-Employed

This first part is very important. If you're making the amount of money you mentioned in your post you need to start making estimated payments to the IRS right now and you need to make the first one IMMEDIATELY. The self-employment tax alone on $34,000 is $5,202, which means your payments will be at least $1,170 every quarter before taking the federal & state income taxes into account. If you don't qualify for an exception to estimated payments you're already late on the first three for this year which mean penalties & interest will inevitably be added on (although you have extra time on the September payment if you live in a federally declared hurricane disaster area for this year). You also must make North Carolina estimated payments.

Now that we've got that out of the way let's go through how taxes work for the self-employed so that you know for the future.

As an independent contractor you're paid on a 1099-MISC with no taxes being withheld. You must pay federal income tax, Medicare tax, and Social Security tax on your income. In addition, you'll owe North Carolina income tax. Payment of the amount owed is due either with your tax return, through estimated payments four times per year, or both, depending on the outcome of your tax return and on how much you earn.

TAX RATES

Medicare Tax: 2.9%

Social Security Tax: 12.4%

Federal Income Tax: DEPENDS ON TAXABLE INCOME AFTER DEDUCTIONS, ETC. (ABOUT 10% FOR MOST TAXPAYERS)

North Carolina Income Tax: 5.75%

So you can reasonable expect to pay 31.05%, or $10,710 in total taxes as an independent contractor. Don't let that figure get to you though because your taxable income may be significantly less than you think, and some of these taxes can also be reduced by claiming tax credits.

You are taxed only on your net income after expenses, so if you have unreimbursed expenses for work that you paid for out-of-pocket then you deduct those costs from your income. The most common costs include supplies & driving a vehicle for work purposes. In your situation you likely also have a home office deduction (we'll get into that later). Your income is reported on Schedule C and the expenses that you incur are deducted directly from that income on Schedule C to arrive at your net income figure. So even though your gross income is $34,000, if you have $15,000 worth of expenses for instance than you are only taxed on $19,000 worth of the income at both the federal and state levels.

The federal & state income taxes can further be reduced by any type of tax credit claimed on their respective returns. The Medicare & Social Security taxes can further be reduced by refundable tax credits on the federal return.

You may have noticed that the Social Security & Medicare rates are more than you've paid in the past if you worked as an employee of someone else. That's because when you're paid as a W-2 employee your employer pays 1/2 of the Social Security tax and 1/2 of the Medicare tax, so you only pay 6.2% and 1.45% respectively. But as an independent contractor you have to pay 100% of the Social Security tax and 100% of the Medicare tax yourself. In short, your dad is saving his company money by not paying you on a W-2.

Each year if you expect to earn $1,000 more then you have to make estimated payments to the IRS and to your state of North Carolina. The estimated payments at the federal level are figured on Form 1040-ES and must be paid quarterly. Your payment amounts are figured by estimating your tax due for the year, multiplying by 90%, and then dividing by four. In other words your payments are equal to 1/4 of 90% of your estimated tax due for the year. There are tax calculators on both the IRS & H&R Block websites that can help you figure your expected tax.

ESTIMATED PAYMENT DUE DATES

April 15th

June 15th

September 15th

January 15th of the Following Year

If an estimated payment due date falls on a weekend or a holiday then the due date for that year is the next business day. Natural disasters also result in an extension of some due dates. For instance, residents of hurricane disaster areas typically get an extra extension on the September & January due dates that runs through the last day of the following January (this is the extension that is in effect for the entire state of Florida and much of Texas for this year).

There are two exceptions to estimated payments at the federal level. The first is that if you (1) are an American citizen, (2) lived in the United States this year, and (3) did not owe any tax last year, then you are exempt from making payments for this year. The other exception is that if at least 90% of your tax liability for this year will be covered by withholdings from another job then you are exempt from making estimated payments. Note that even if you meet the criteria for an exemption and you take the exemption you will still owe the tax on your tax return and in addition to that you'll have the first estimated payment for next year also due on April 15th assuming that you're still an independent contractor next year. This is why I made a point of instructing you to start making estimated payments right away. If you don't start making payments you could be looking at a $10,000+ tax bill with your tax return (including state). Again though there are ways to reduce it as I previously mentioned, so you should figure your expected tax return before letting that get to you too much.

You asked about setting up an LLC or an S-corporation. Starting a business in your field as a special type of entity is not necessarily going to help reduce your tax. An LLC owner files the same Schedule C as an independent contractor if he or she is the sole owner of the business. An S-Corporation files an 1120-S tax return and can potentially save some money, but an S-Corporation must pay it's owner(s) at least the average that they would make in their line of work in their area before it can declare a profit and retain excess earnings. You still have to pay the self-employment tax on your pay from the S-Corporation, but if the company profits more than what it's required to pay you the excess that is retained by the S-Corporation is not subject to self-employment tax but it does pass through to you as additional income. So for example if you are an electrician and electricians earn an average of $35,000 in your area, and your S-Corporation earned a net profit before paying you of $50,000 then what would happen is you would have to pay yourself $35,000 on a W-2 and the S-Corporation would pay its part of the social security & Medicare taxes on your income and then retain the remainder of the earnings. You would have an income of $35,000 plus since you own the corporation you would have roughly another $13,000 that would pass through to you as additional income reported to you on Schedule K-1.